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There is no U.S. government guarantee to protect the largest financial firms, a Treasury Department official said, as a congressional watchdog criticized the $45 billion in government aid provided to Citigroup Inc.

Herbert Allison, who oversees the Treasury’s $700 billion financial-rescue plan, disagreed with members of a congressional oversight panel that some financial firms benefit from the assumption that the government would step in to prevent their failure.

“There is no too-big-to-fail guarantee on the part of the U.S. government,” Mr. Allison said.

The weird thing here is that Treasury itself has made it explicit that there are too-big-to-fail institutions in the US: it even created an official bureaucratic acronym for them: Tier 1 FHCs. These are the banks and other financial institutions which are so big and interconnected that they’re going to need extra levels of capital and prudential regulation in an attempt to minimize the chances of their ever coming close to failure.

But there’s only one reason why the government should carefully regulate a set of companies so as to ensure that they don’t fail. And we all know what that reason is: if they were ever to fail, the government would be forced to step in and bail them out.

It’s also simply false for Allison to assert deny that TBTF banks “benefit from the assumption that the government would step in to prevent their failure”. Even if he’s right that the guarantee doesn’t exist (and he’s wrong about that, just as Treasury was wrong every time it said there wasn’t a US government guarantee of Fannie and Freddie), the fact remains that the markets believe that the guarantee exists, and that the cost of funds at TBTF banks is lower as a result. That’s undeniable.

So why is Allison peddling fiction in front of the Congressional Oversight Panel? Johnson puts it well:

If Mr. Allison was sticking to his talking points, as seems likely, let us find out exactly who is responsible for sharing arrant and self-defeating nonsense with Congress.

It’s a good question. Is this Geithner’s doing? Is Treasury now even more captured by America’s biggest banks than it was in the initial months of the Obama administration? Or is this simply an admission that financial reform is going nowhere, and that we’re going to return to the status quo ante of Treasury refusing to admit that it will ever bail out anybody, and then going ahead and doing that anyway?